Fitch Ratings has affirmed Telefonica Moviles Chile S.A. (TMCH) and Telefonica Chile S.A.'s (TCH) Long-Term Foreign Currency and Local Currency Issuer Default Ratings (IDRs) at 'BBB+' and revised the Rating Outlook to Negative from Stable.

The ratings reflect the group's leading market position in mobile and fixed-line segments as well as a relatively moderate financial profile.

The Negative Outlook reflects the continuation of a deterioration in the company's credit profile as a result from the challenging competitive environment in Chile, lower profitability, strong dividend upstream and the net impact of the company's sale of its stake in its fiber assets.

Key Rating Drivers

Leverage Weakening: TMCH has historically had one of the strongest financial structures in the region, with net leverage metrics historically around 1.0x supported by consistent cash flow generation. However, Fitch projects the company's financial structure will weaken, particularly when considering the impact of lease obligations, as the effects of the sale of the fiberco and competition in the Chilean telecom market limit EBITDA growth. Fitch expects net debt to rise as cash flow is used for dividends to the parent company, resulting in projected net leverage increasing to around 1.8x in 2023, and 2.9x on a lease-adjusted basis.

Reduced Profitability: The sale of the 60% stake in the fiber infraco in 2021 has pressured TMCH's EBITDA as the company's opex now includes higher expenses due to connectivity to the infraco's fiber optic network. Operating expenses are also elevated due to higher expenses associated with TV content and commissions. Post-tax cash inflows from the sale of the fiberco stake have been upstreamed to the parent company, contributing to an increase in leverage metrics. Positively, the fiberco will be responsible for all of its own capex as Telefonica Chile will not contribute additional capital to fund its network expansion plans.

Challenging Mobile Environment: Fitch expects the mobile segment to grow modestly over the coming years as competition remains fierce in the four-player Chilean market. Mobile service revenues grew a modest 3% yoy in 2021 despite strong subscriber growth of 7% as ARPUs in both prepaid and postpaid have been under pressure due to competition. Positively, the company has continued to steadily increase its relative share of postpaid users, with over 61% of mobile subscribers in 1H22 on a postpaid plan compared with 56% at YE 2020.

Leading, Diversified Competitive Position: TMCH's diverse revenue streams offset its lack of geographic diversification, and the company has solid market share positions across the fixed and mobile segments. TMCH is the second-largest mobile provider (24% of subscriber market share) and TCH is the largest broadband (31%) and second-largest pay TV (20%) provider in the country, while key competitors ENTEL (BBB/Stable) and VTR Finance N.V. (BB-/Negative) have a focus on the mobile and fixed segments, respectively. TCH has gained subscribers from VTR as customers in Chile continued to gravitate towards Movistar's faster fiber broadband offering.

Broadband Drives Fixed Line Growth: Fixed segment revenues have grown rapidly in recent years driven by market share gains in broadband and pay-TV subscribers. Supported by its market-leading fiber broadband service offering, the company has surpassed VTR to become the industry leader in broadband internet. Furthermore, bundling offers and a strong IPTV product have allowed the company to grow its market share in pay-TV. While competition in fiber should increase as competitors expand their own fiber networks, Fitch anticipates that TCH will maintain its dominant position in fixed telecom services. With broadband penetration in Chile still below the Organization for Economic Co-operation and Development (OECD) average, Fitch expects continued strong growth in broadband subscribers and revenue over the rating horizon.

Parent Subsidiary Linkages: TMCH and TCH both possess strong stand-alone credit profiles, in line with their rating level. Fitch equalizes the two companies' ratings, given the shared operational and administrative functions, along with the material dividend remittances from TCH up to TMCH. The complementary nature of the companies' product portfolios further supports Fitch's assessment of strong strategic linkages. TCH and TMCH are rated one notch higher than the ultimate parent Telefonica SA (TEF, BBB/Stable) as TCH and TMCH have stronger credit profiles than TEF. According to Fitch's parent-subsidiary linkage criteria, legal ring-fencing is considered open, while access and control are considered porous, allowing for a one-notch rating differential. TEF's Latin America subsidiaries typically operate with a high degree of operational and financing autonomy from the parent, supporting the view of porous access and control.

TCH's Equity Rating: TCH's listed stock accounts for less than 1% of the company's equity. The rest is held by TMCH. The equity rating for TCH is Level 4(cl), given the low level of free float due to the majority stake ownership by TEF. This is mitigated by its solid solvency and long history in the Chilean stock market.

Derivation Summary

Compared with America Movil, S.A.B. de C.V. (AMX; A-/Positive), TMCH has a similarly strong financial structure characterized by low leverage metrics, contributing to AMX and TMCH's positions at the upper end of the sector rating range. AMX's scale and geographic diversification is much higher than TMCH's, with a service footprint across Latin America, and AMX also maintains a stronger competitive position with market leadership in nearly all of its markets.

Compared with domestic competitors Empresa Nacional de Telecomunicaciones SA (ENTEL; BBB/Stable) and VTR Finance N.V. (BB-/Negative), TMCH has stronger product diversification as the market leader in broadband internet and the #2 player in mobile, while ENTEL and VTR have a focus on mobile and fixed, respectively. TMCH also has lower leverage and stronger pre-dividend FCF than ENTEL, although ENTEL benefits from its geographic diversification into the Peruvian market and the larger scale of its combined operations. Compared with other Chilean competitor WOM S.A. (BB-/Stable), TMCH has much lower leverage, as well as greater scale and service diversification.

TMCH's lower leverage and higher FCF also compare favorably with sister companies Telefonica del Peru S.A.A. (BB+/Negative) and Colombia Telecomunicaciones S.A. E.S.P (BBB-/Stable). Fitch expects competition to remain high in each market, although higher GDP per capita in Chile contributes to a more sustainable market than in both Peru and Colombia. Telefonica del Peru has much weaker profitability than the other two.

Key Assumptions

Mobile subscribers surpassing 8.0 million as the company's postpaid penetration continues to increase; blended mobile ARPU (service + handsets) declining to CLP9.5 thousand in FY 2022 (compared with CLP9.6 thousand at FY 2021) as competitive pressures in mobile continue, partially offset by continued conversion to postpaid;

Fiber homes passed increasing to around 4.8 million by FY 2024, with take up rate (homes connected/homes passed) increasing from 37% to around 39%, some gains in IPTV while fixed voice continues its secular decline;

Overall revenues growing to around CLP1.7 billion in FY 2022 versus CLP1.6 billion in 2021; growing modestly thereafter mainly driven by growth in postpaid and fiber broadband;

EBITDA margins below historic averages, settling below 20%, mainly due to wholesale network charges associated with the fiberco (around 40% of broadband revenues);

Capex declining from elevated levels in 2021, which were mainly affected by significant mobile network rollout, while the capex related to fiber will decline beginning in 2022 following the fiberco divestment in 2021; Capital intensity will be in the mid-teens range to support the company's network;

FCF expected to be negative over the rating horizon reflecting dividends and weaker profitability.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade is unlikely, due to the competitive pressures in the Chilean market;

Stabilization of the rating will depend on improving profitability and cash flow generation while sustaining the company's market position;

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A deterioration in market position due to competition and/or regulation, resulting in negative FCF generation and net leverage increasing to over 2.0x, or lease-adjusted net leverage over 2.5x, on a sustained basis;

A higher degree of financial integration between the units of Telefonica HISPAM (Chile, Colombia, Mexico, Peru, etc.) could result in a ratings downgrade if it involved increased leverage or cash movements;

Excessive shareholder distributions, including from cash flow from operations or from additional asset sale proceeds being distributed to the parent company.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Strong Liquidity: Telefonica Moviles Chile's commitment to a conservative financial profile, consistent pre-dividend FCF generation (ex-spectrum), and FX hedging all support the company's strong liquidity and flexibility. As of June 30, 2022, the company had cash and equivalents of CLP585 billion against short-term debt of CLP258 billion. TCH has a USD500 million note coming due in October 2022, which will be repaid using proceeds from the 2031 notes issued in November 2021. The group's debt amortization profile is relatively short dated, but will extend when the refi is completed. Longer term, Fitch expects that TMCH will maintain around CLP250 billion of cash, and generate around CLP20 billion-CLP30 billion of pre-dividend FCF.

Issuer Profile

Telefonica Moviles Chile is an integrated Chilean telecommunications provider that operates mobile and fixed-line platforms under the Movistar brand. The company offers mobile voice, mobile data, broadband internet, pay TV, and digital services to consumers, businesses, and government clients. The company is owned by Telefonica S.A.

Summary of Financial Adjustments

Lease Obligations: When appropriate to the issuer's business model, Fitch may present additional ratios to supplement the core approach.

Telefonica Moviles Chile's rental expense is relatively high compared with its telecom peers given its asset sales in recent years. Fitch supplements TMCH's core unadjusted credit metrics with lease-adjusted metrics. As part of these adjustments, Fitch excludes right of use asset amortization and interest associated with leases from EBITDA. Fitch capitalizes the annual lease charge using a standard 7x multiple for Chilean issuers to create a debt equivalent.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

(C) 2022 Electronic News Publishing, source ENP Newswire